Business leverage is an important tool to help businesses understand and better manage risks and opportunities in business. By intelligently applying leverage, managers can optimize profits and enhance the overall performance of the business. In this article, 1C Vietnam will provide information on understanding the concept of business leverage, along with specific examples and leverage calculation formula.

1. What is business leverage?

Operating leverage , also known as operating leverage, is an important concept in the field of corporate finance that helps reflect the influence of business cost structure (including fixed costs). fixed and variable costs) to profits before taxes and interest when there is a change in revenue.

Given a constant business cost structure, operating leverage indicates the percentage change in profits before taxes and interest relative to a 1% change in sales. This is known as the tilt of operating leverage or its degree of impact, often expressed by the DOL index (Degree of Operating Leverage).

2. Example of effective business leverage

An enterprise operates in the field of manufacturing product Y, with a unit selling price of 400,000 VND. Fixed business costs are 800 million VND, while variable costs are 320,000 VND for each product. It is required to determine the economic break-even output and evaluate the impact of business activities when output reaches 23,000 Y products.

Based on the above data, we can calculate the economic breakeven output of the enterprise

Qh= 800,000,000/400,000-320,000=10,000 Y products

The level of impact of business leverage at the production output level of 23,000 products Y:

DOL=23,000x(400,000-320,000)/(23,000x(400,000-320,000)-600,000,000)=1.48

In addition, to better understand the impact of business leverage, suppose the business has reached the production level of 23,000 products. If sales volume increases by 1%, profits before interest and taxes will increase by 1.48%. On the contrary, if sales volume decreases by 1%, profit before interest and taxes will also decrease by 1.48%. This shows the flexible impact of business leverage on an enterprise's business operations.

3. Formula to calculate the level of business leverage

The formula to calculate the degree of operating leverage (DOL) is:

DOL= (Change in profit before tax and interest/Profit before tax and interest)/(Change in revenue/Revenue)

In there:

• Change in profit before tax and interest is the change in profit before tax + interest when revenue changes.
• Profit before tax and interest is profit before tax + interest.
• Change in revenue is the change in revenue.
• Revenue is the total revenue from sales.

This formula helps measure the impact of changes in revenue on a business's profit before taxes and interest. The higher the level of business leverage, that is, each unit increase/decrease in revenue will create a larger proportion of increase/decrease in profit before tax and interest.

4. Types of business leverage for businesses

Business leverage helps businesses expand their scale by using loans or other finance to take advantage of investment opportunities and increase their competitive position. Common types of business leverage in businesses include:

• Financial Leverage : Financial leverage is the use of borrowed capital to increase the profitability of a business. In this way, businesses can increase investment activities or expand business without using equity capital. However, financial leverage also comes with higher financial risk due to interest payments.
• Sales Leverage : Sales leverage focuses on increasing sales and revenue by optimizing sales and marketing strategies. In this way, businesses can take more advantage of market opportunities and enhance financial performance.
• Cost Leverage: Cost leverage emphasizes reducing the production and operating costs of the business. In this way, businesses can improve profits and financial performance through optimizing cost management and improving production efficiency.
• Synthetic leverage : Is a combination of financial leverage and operating leverage to optimize the overall performance of the business. Instead of focusing on just one specific type of leverage, integrated leverage looks at the entire business system and applies appropriate strategies to optimize profits and overall performance.

5. How to apply business leverage effectively

To take advantage of business leverage and accelerate company growth, cash flow management is the top factor to consider. The principle of leverage is the effective use of costs and debt capital.

To achieve maximum efficiency from leverage, you need to focus on creating the highest net profit for the company. It should be remembered that the use of leverage has a great impact on a company's business operations. Therefore, as a business owner, you need to carefully calculate and evaluate options to manage and respond to risks.

For example, if a company uses financial leverage without effectively utilizing debt capital, it can result in profits before interest and taxes being smaller than interest expenses, causing a decrease in return on capital. Owner. This requires timely countermeasures to avoid severe damage.

Thus, the above article has summarized business leverage as well as the formula to calculate the level of business leverage. If you have any questions, please contact 1C Vietnam for support.